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Office Marketbeat Report

Manami Chisaki • 29/01/2024

ECONOMY: Tokyo’s Employment Recovery Continues, Led by Growth in Technology Sector

Japan’s annual real GDP growth is expected to decelerate to 1.0%in 2024 from 1.6% in 2023 as global economies continue to normalize from the pandemic. According to the quarterly corporate earnings survey conducted by the Ministry of Finance, improving corporate earnings through Yen weakness started to decelerate with the aggregate ordinary income in Q4 2023, down 5% y-o-y, led by weakness in the manufacturing sector, down 10% y-o-y5. Tokyo’s unemployment rate ticked up by 0.4pp from Q3 2019, as an increasing number of young employees opted out of the workplace. However, the overall rising labor participation rate lifted Tokyo’s total employment figure to 8.4 million, growing at CAGR of 1.0% from Q3 2019. This compares to the corresponding national employment growth rate of 0.1%. By industry, technology sector employment grew at CAGR of 1.2%, while the wholesale & retail sector fell by CAGR of minus 2.9%, both from the baselinefigures as of Q3 2019.

SUPPLY & DEMAND: Expect Tight Supply-Demand Balance in 2024 With Fading Impact of Supply Cycle

CycleThe Tokyo Central 5 Wards Grade A office net absorption for the full-year 2023 was at 5,064 ksf, up 50.9% from the previous year. However, the vacancy rate increased 1.5pp y-o-y to reach 4.9% in Q4, with the availability rate up 0.5pp y-o-y to 6.8%, largely attributed to the volume of new supply through 2023 in the Toranomon/Kamiyacho and Mita/Tamachi submarkets. Elsewhere, the Harumi submarket remained soft, with the vacancy rate nearly doubling to 25.2% over the past twelve months. However, excluding these area-specific impacts in three submarkets, the Tokyo Central 5 Wards Grade A office vacancy rate remained stable at 2.4%, down 0.8pp y-o-y. Occupancy was at 70.5% for newly completed buildings in Q4 (NLA: 6.8 msf) and projected at 29.9% for incoming projects within the next twelve months (NLA: 2.7 msf). With scheduled incoming supply in 2024 slowing to 60% of the 10-year historical average, some landlords have opted to raise rents more quickly, while more tenants are pausing relocations until the next supply influx due in 2025, at nearly double the 10-year historical average.

Employment growth in the Tokyo C5W has been outpacing corresponding growth in available office stock since 2016, leading to office space per worker falling by 18%. With projected employment growth at 5Y CAGR of 1.6% until 20256, anchored by growing technology employment at 6Y CAGR of 4.5%6, overall demand is expected to remain stable. Key tenant relocation criteria also reveal growing demand for upgrades, better locations, and/or higher-grade facilities. Despite strategic floor reductions following the pandemic, higher office attendance rates have led to a growing shortage of workspace, pushing more workers towards serviced office providers. More flexible use of office space is likely to limit further demand weakness, leading to tighter market conditions ahead at least during the relative pause in new supply scheduled for 2024.
 

PRICING: Rental Cycle Bottoming Out, Expect Near-Flat Rental Movements With a Shift to Inflationary Environment

The Tokyo C5W Grade A average assumed achievable rent ("rent”) softened by 0.1% y-o-y in Q4 2023 to record ¥34,532, with asking rent also ticking down by 0.8% y-o-y. Upward pressures on rents are emerging, with more transactions closing without offering sales concessions. Downward pressures on rents includes the incoming supply influx in 2025, bifurcated vacancy trends pressuring lower-quality buildings, and rising fit-out costs. According to the Construction Research Institute, the Tokyo office construction cost index has risen by 27.4% during the past eight years. However, more landlords are now opting to waive fit-out charges as an alternative tenant incentive to help match asking rent with achieved rent pricing.
 

 

OUTLOOK
  • Expect nominal rent to remain near-flat.We expect the net effective rent to decline around 2% on real terms over the next two years. Ongoing demand recovery led by employment growth, input cost increases, and incoming supply at higher-than-average rent pricing are likely to limit further downside in rents. We recommend landlords to maintain a flexible leasing strategy. We recommend tenants to explore more diversified leasing strategies as options of longer free-rent periods and/or reduced cost charge-back to tenants may become available.
  • Expect a temporary pause in vacancy rates in 2024 followed by an uptick toward 6% in 2025. We expect Tokyo C5W Grade A office vacancy to remain steady during the relative supply pause in 2024, followed by a measured rise towards 6% over the next two years. With new supply then doubling from 2025, excess supply over stable office demand is likely to expand vacancy in lower-grade buildings.

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